Outside the Box

The Keynesian Depression

February 22, 2013

In today’s Outside the Box, Scott Minerd, chief investment officer of Guggenheim Funds, regales us with the not-always-happy history of Keynesian economics – we did what he said when we had to, but not always when we should have. Shoving fiscal and monetary stimulus down the throat of a recession is well and good, but how about the part where we’re supposed to be fiscally conservative during boom times? “What, raise taxes? No thank you!”

The upshot, as Minerd reminds us, is that “As a result of the constant fiscal support without the tax increases, businesses and households became comfortable operating with continuously higher leverage ratios. The conventional wisdom was that this government backstop could never be exhausted.” Today we are testing that premise to the limit, and not only in the US.

Keynes forged his ideas in the fires of the Great Depression, but his disciples have, as Minerd wryly notes, “carried his views much further than could have been imagined during the period in which the master lived.” Consequently, the downturn we now struggle to escape from is very different from the one that plagued the world of the 1930s. The key difference, Minerd tells us, is that:

… for the first time since the 1930s, we have had severe asset deflation (declining real prices) in the face of relative price stability. Periods of asset deflation occurred between the 1960s and 1990s, but nominal prices were supported by rising inflation levels…. This protected asset-based lenders from severe losses resulting from declining nominal prices.

During the 2008 crisis, inflation levels were close to zero and unable to offset falling real asset values to stabilize nominal prices. This caused a debt deflation spiral to take hold as nominal prices fell. In contrast to the Great Depression, policymakers took extreme measures in 2008 to prevent a total collapse of the financial system and head off a deflationary spiral like that experienced in the 1930s. These policies included sharply increasing the money supply and engaging in an unprecedented amount of deficit spending.

To say the least. And all the easing and deficit spending worked to stave off financial disaster – up to a point. The problem is, we have just about reached that point – the point where, as Rogoff and Reinhart have so firmly instructed us, things turn out not to be that different after all. So let’s jump into Minerd’s take on the big picture, and see what he thinks the implications are for our investments.

But first, let me reveal that I find myself in Palm Springs this morning, getting ready to take a few hours off and embarrass myself with friends at the Indian Wells Golf Resort. Greg Weldon was on the plane last night (at 6’10”, he has to be the tallest analyst in the writing game), and he told me to bring my “A” game to the golf course, as we’d be playing together. I just laughed and said I didn’t even have an “X” game. I think if I shoot anything close to 120, I will just declare victory and walk to the clubhouse with a smirk. Big difference from my attitude in the “old days,” when I had time (and a back) to play. Bottom line: It’s a great course and a beautiful day, and I don’t make my living with a golf club in my hand. Greg, on the other hand, brings the same intensity to everything he does, whether it’s trading or golf or the World Series of Poker. I will watch him exult and curse, maybe on the same hole. I only get intense these days when I write. C’est la guerre.

Grant Williams is in town, and we will be spending a lot of time the next few days comparing notes and doing some videos for our readers (that would be you, and you’ll see them shortly). As everyone knows, I am a huge Grant Williams fanboy. It helps that he is also one of the nicest human beings anywhere.

I am speaking at the Cambridge House Natural Resources Conference here. Rick Rule of Sprott is coming in, and we will have dinner. My Mauldin Economics team partners are also in town, to help with the video and plan out some great new letters. I am really excited about the directions we are taking. They are opening up whole new ways for me to help you.

Oddly, it is colder here in Palm Springs than it was back in Dallas, but pleasant all the same. Have a great weekend.

Your wondering where his ball went analyst,

(The real editor’s note: John apparently finished this on his iPad at the third hole. He was probably not kidding about having lost his ball.)

John Mauldin, Editor
Outside the Box

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The Keynesian Depression

A Premonition From a Halcyon Era

By Scott Minerd, Chief Investment Officer, Guggenheim Funds

In 1968, America was literally over the moon. Apollo 7 had just made the first manned lunar orbit and the nation would soon witness Neil Armstrong’s moonwalk. The United States was winning the war in Southeast Asia and the Great Society was on the verge of eliminating poverty. I remember my father taking me to the Buick dealership that summer in Connellsville, Pennsylvania, where he bought a 1969 Electra. As we drove home I asked him why we had bought the 1969 model when we had the 1968 one, which seemed equally good.

“That’s just what you do now,” my father said, “Every year you go and get a new car.” “Wouldn’t it be better,” I asked as a precocious nine year-old, “if we saved our money in case a depression happened?” I will never forget my father’s reply: “Son, the next depression will be completely different from the one that I knew as a boy. In that depression, virtually nobody had any money so if you had even a little, you could buy nearly anything. In the next depression, everyone will have plenty of money but it won’t buy much of anything.” Little did I realize, then, how prescient my father would prove to be.

Five years have passed since the beginning of the Great Recession. Growth is slow, joblessness is elevated, and the knock-on effects continue to drag down the global economy. The panic in financial markets in 2008 that caused a systemic crisis and a sharp fall in asset values still weighs on markets around the world. The primary difference between today and the 1930s, when the U.S. experienced its last systemic crisis, has been the response by policymakers. Having the benefit of hindsight, policymakers acted swiftly to avoid the mistakes of the Great Depression by applying Keynesian solutions. Today, I believe we are in the midst of the Keynesian Depression that my father predicted. Like the last depression, we are likely to live with the unintended consequences of the policy response for years to come.

This Depression is Brought to You By...

John Maynard Keynes (1883—1946) was a British economist and the chief architect of contemporary macroeconomic theory. In the 1930s, he overturned classical economics with his monumental General Theory of Employment, Interest and Money, a book that, among other things, sought to explain the Great Depression and made prescriptions on how to escape it and avoid future economic catastrophes. Lord Keynes, a Cambridge- educated statistician by training, held various cabinet positions in the British government, was the U.K.’s representative at the 1944 Bretton Woods conference and, along with Milton Friedman, is recognized as the most influential economic thinker of the 20th century.

Keynes believed that classical economic theory, which focused on the long-run was a misleading guide for policymakers. He famously quipped that, “in the long run we’re all dead.” His view was that aggregate demand, not the classical theory of supply and demand, determines economic output. He also believed that governments could positively intervene in markets and use deficit spending to smooth out business cycles, thereby lessening the pain of economic contractions. Keynes called this “priming the pump.”

On Your Mark, Get Set, Spend

Since the Second World War, policymakers concerned with both fiscal and monetary policy have opportunistically followed certain Keynesian principles, particularly using government spending as a stabilizer during periods of economic contraction. In 1968, steady economic growth and low inflation had led optimists to declare that the business cycle was dead. When President Nixon ended gold convertibility of the dollar in 1971 he justified it by declaring that he was a Keynesian. Even Milton Friedman, founder of the monetary school of economics, told Time magazine that from a methodological standpoint, “We’re all Keynesians now.”

In dampening each successive downturn, authorities accumulated increasingly larger deficits and brought about a debt supercycle that lasted in excess of half a century. The complementary aspect of Keynes’ guidance on deficit spending – raising taxes during upswings – was rarely followed because of its political unpopularity. As a result of the constant fiscal support without the tax increases, businesses and households became comfortable operating with continuously higher leverage ratios. The conventional wisdom was that this government backstop could never be exhausted.

The calamity in the financial system in 2007 and 2008 signaled the beginning of the unraveling of the global debt supercycle. The Keynesian model dictated that the best way to fix the problem was to run large deficits and increase the money supply. Keynes had based his prescriptions for this type of action on the early mismanagement of the Great Depression which he felt had prolonged the losses and hardship during that time. As is the case with most groundbreaking philosophies, Keynes’ disciples carried his views much further than could have been imagined during the period in which the master lived.

The Depression My Father Knew

Keynes viewed governments’ attempts at belt-tightening during the Great Depression as ill-timed. Although President Roosevelt invested in massive public works projects under the New Deal starting in 1933, almost four years into the crisis, the U.S. government maintained a policy of attempting to balance the budget as the depression raged on. Keynes’s response was: “The boom, not the slump, is the right time for austerity at the Treasury.” The other problem, according to Keynes, was that the Federal Reserve’s attempts to lower real interest rates and inject cash into the system were too modest and too late to avoid what he referred to as a liquidity trap, leading people to hoard cash instead of consuming.

To illustrate the dynamics of the liquidity trap Keynes cleverly invoked the analogy of “pushing on a string.” He said that at some point, attempting to stimulate demand by easing credit conditions is like trying to push a string that is tied to an object you want to move. Whereas you can easily pull something toward you by the string to which an object is tied (raising interest rates to slow growth), attempting to carry out the opposite by reversed means (lowering interest rates to try to induce lending to otherwise unwilling borrowers) is not always successful. This is especially true when the rate of inflation becomes so low that it becomes impossible to set interest rates below it.

This Time It’s Different

What sets the current downturn apart from any other since the Great Depression is that, for the first time since the 1930s, we have had severe asset deflation (declining real prices) in the face of relative price stability. Periods of asset deflation occurred between the 1960s and 1990s, but nominal prices were supported by rising inflation levels. Against the backdrop of a rising price level, nominal asset prices remained stable or continued to increase as real asset prices declined. This protected asset-based lenders from severe losses resulting from declining nominal prices.

During the 2008 crisis, inflation levels were close to zero and unable to offset falling real asset values to stabilize nominal prices. This caused a debt deflation spiral to take hold as nominal prices fell. In contrast to the Great Depression, policymakers took extreme measures in 2008 to prevent a total collapse of the financial system and head off a deflationary spiral like that experienced in the 1930s. These policies included sharply increasing the money supply and engaging in an unprecedented amount of deficit spending.

In many ways the swift policy action proved highly effective. Instead of the 25 percent unemployment seen in the 1930s, joblessness reached only 10 percent. While unemployment now stands at roughly eight percent, if one uses the labor force participation rate from 2008, the level is still higher than 11 percent. Although there was a 3.5 percent decline in the price level between July and December of 2008, policymakers immediately tackled and reversed the deflationary spiral. This compares with the Great Depression, when between 1929 and 1933 the general price level declined by 25 percent.

The Aftermath

Though some may be cheered by the relative policy successes this time around, at the current trajectory it will still take almost as long for total employment to fully recover as it did in the 1930s. While job loss was not as severe this time, the recovery in job creation has been much slower. Although nominal and real gross domestic production have returned to new highs on a per capita basis, we are still below 2007 levels. In the same way the Great Depression and the depressions before it lasted eight to 10 years, we will likely continue to see constrained economic growth until 2015-2016 (roughly nine years after U.S. home prices began to slide). Only then will the excess inventory in the real estate market be absorbed, allowing the plumbing of the financial system to function, and supporting an increase in the economic growth rate.

At what cost did we attain this “success”? Like any strong medicine, the policies pursued since 2008 have had, and are continuing to have, unintended side effects. The most glaring feature of today’s global landscape is that governments around the world have exhausted their capacity to borrow money and have turned to their central banks to provide unlimited credit. In the United States, it has taken an average annual deficit of $1.2 trillion and multiple rounds of quantitative easing just to keep the economy growing at a subpar rate since 2009.

In their 2009 book, This Time It’s Different: Eight Centuries of Financial Folly, the economists Carmen Reinhart and Kenneth Rogoff catalogue more than 250 financial crises and conclude that the U.S. cannot reasonably expect to circumvent the outcome that has befallen all overleveraged nations. In the authors’ words:

...Highly leveraged economies, particularly those in which continual rollover of short-term debt is sustained only by confidence in relatively illiquid underlying assets, seldom survive forever, particularly if leverage continues to grow unchecked.

Sovereign powers saddled with debt loads as large as those of the U.S., Europe, and Japan today are jeopardizing their long-term economic wellbeing.

In an October 2012 whitepaper, Reinhart and Rogoff re-emphasized their findings that the U.S. cannot expect to quickly emerge from what occurred in 2008. They point out that 2008 was the first systemic crisis in the U.S. since the 1930s so the consequences have been much more significant than fall-outs from normal recessions.

What Comes Next?

The most important question for investors concerns how public sector debt levels, which have risen exponentially over the past half-decade, will ultimately be discharged. As Reinhart and Rogoff discuss, there are three options to reducing debt levels. The first is restructuring, also known as default. For obvious reasons this is painful and typically avoided except under the most dire circumstances. Governments can also pursue structural reform, which in today’s case would mean greater austerity. Implementation of this would stand in stark opposition to Keynes’s recommendation that the fiscal and monetary spigots be kept open during hard times. Although tightening is arguably the best long-term path, it appears unlikely that it will be the primary policy of choice in the near future. The third method, toward which I see global central bankers drifting, is to keep interest rates artificially low and permit increasing levels of inflation in the economy.

Pushing down the cost of borrowing and allowing the price level to rise is known as financial repression. The real value of debtors’ obligations is reduced by financially repressive policies. Keynes warned of the dangers of inflation in his early work, The Economic Consequences of the Peace, which presciently criticized the harshness of the Treaty of Versailles:

...By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens ... As inflation proceeds and the real value of the currency fluctuates wildly, all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless.

Keynes re-iterated his views in the mid-1940s when he visited the United States and saw programs that were touted as Keynesian although he viewed them as primarily inflationary.

Financial repression is nothing new. Between the 1940s and the early 1980s, the United States reduced its national debt from 140 percent of GDP to just 30 percent while continuing to run sizable deficits. The difference between then and now is the magnitude of the debt mountain on the Federal Reserve’s balance sheet that will need to be eroded. A subtle shift has begun in which policymakers are starting to think of inflation as a policy tool rather than the byproduct of their actions. Despite Keynes’ warnings, it appears that higher inflation will continue to be the monetary tool of choice for central bankers tasked with cleaning up sovereign balance sheets.

Investment Implications

The long-term downside of mounting inflationary pressure will ultimately accrue to bondholders and income-oriented investors. The case can be made that we are marching headlong into a generational bear-market for bonds. During the next decade, holders of Treasury and agency securities will likely realize negative real returns. Despite this, these assets continue to trade at extremely rich valuations. Exactly when the market will awaken to this anomaly in securities pricing remains to be determined. The analogy I would use for the current interest rate environment is that of a balloon being held underwater. When the Fed withdraws from the market and allows interest rates to find their economic level, the balloon will inevitably ascend.

If investors need to stay in fixed-income assets, they should consider transitioning into shorter-duration credit and floating-rate products like bank loans and asset-backed securities. If duration targeting is a concern for liability-matching purposes, adjustable-rate assets can be barbelled with long-duration securities like corporate bonds or long duration agency mortgage securities. Equities and risk assets are likely to rise as the money supply grows.

Gold, as I discussed in my October 2012 Market Perspectives, “Return to Bretton Woods,” has significant upside potentially and should be considered for inclusion in any portfolio designed to preserve or grow wealth over the long-term. Depending on the scale of the current round of quantitative easing and the decline in confidence in fiat currencies, the price of an ounce of gold could easily exceed $2,500 within a relatively short time frame and could ultimately trade much higher.

The World is Waiting

The Great Depression brought about the Keynesian Revolution, complete with new analytical tools and economic programs that have been relied upon for decades. The efficacy of these tools and programs has slowly been eroded over the years as the accumulation of policy actions has reduced the flexibility to deal with crises as we reach budget constraints and stretch the Fed’s balance sheet beyond anything previously imagined. Nations have exceeded their ability to finance themselves without relying on their central banks as lenders of last resort and increasingly large doses of monetary policy are required just to keep the economy expanding at a subpar pace. Some have referred to this as reaching the Keynesian endpoint.

Keynes would barely recognize where we now find ourselves. In this ultra loose policy environment we are limited by our Keynesian toolkit. Today, the world is waiting for someone to come forward and explain how we are going to get out of our current circumstances without suffering the unintended consequences created by so-called Keynesian policies.

Early in his life, Abraham Lincoln wrote that he regretted not having been present during the founding of the nation because that was when all the positions in the pantheon of great American leaders were filled. By resolving America’s Imperial Crisis through the Civil War and the abolishment of slavery, Lincoln would go on to join those lofty ranks himself. Much like that crisis needed Lincoln, the current crisis needs someone who can identify new tools to resolve the present economic crisis. Until then we are condemned to a path which leads to further currency debasement and the erosion of purchasing power, with the result being a massive transfer of wealth from creditor to debtor. Without a new economic paradigm, the deleterious consequences of the current misguided policies are a foregone conclusion. It would seem my Dad could hardly have been more correct when he described the next depression from behind the wheel of his 1969 Buick.

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Brian McMorris 46364174

Feb. 27, 2013, 8:28 a.m.

Ben Bernanke is happy to talk about how beneficial QE has been to the economy and at such little cost.  He will claim that the Fed’s ability to expand its balance sheet has no negative side effects and is producing no excess inflation, and will not do so in the future.  Bernanke reassures us that the Fed can withdraw its accommodation at the right time and without any serious negative consequence. 

How so?

There is very little discussion anywhere in investment, economic or political circles about how the Fed withdraws accommodation.  Any serious thought given to the subject should cause great concern.  The Fed creates accommodation or Quantitative Easing, by buying Congressionally authorized securities.  What is authorized by Congress are US Treasuries and “agency bonds” (GSE mortgage backed bonds).  The funds to pay for these securities are fabricated with bookkeeping entries on the Fed balance sheet.  This is effectively “printed money” that does not exist prior to the event of purchase.  The process of buying Treasury securities effectively lowers interest rates because it increases demand for a fixed supply of those securities, raising the face value of the bonds which lowers the interest rate.

Once the securities are purchased, the Fed is required to place those securities into the banking system.  Banks receive the funds as deposits and can therefore lend against those deposited securities.  A key reason for the Fed to expand its balance sheet is to encourage bank lending to spur the economy.

How is all of this policy reversed?  No one wants to confront the elephant in the room.  Here is what must happen to unwind accommodation: the Fed must shrink its balance sheet back to “normal” levels of 5-6% of GDP from the 20-25% of today.  To do this, the Fed must sell all the securities it has purchased, primarily US Treasuries but also mortgage agencies.  How does this happen and what are the knock-on effects?  The Fed reacquires the securities it has parked in the banking system, decreasing the banking industry’s ability to lend, contracting the economy.  As it sells the securities into the market, who will buy?  Consider that the Fed is currently buying 70-90% of each Treasury auction.  Are there any private buyers of Treasuries who will bid after the Fed has spent several years convincing
the private sector to get out of Treasuries?  At what price (interest rate) will the Treasuries get sold into the private sector?  Surely a lot higher than today:  3% higher, 4% higher?

What happens when the Fed is selling rather than buying?  Not only do interest rates soar higher as the Fed leaves the market as the primary (70%+) bidder, but the funds in the private sector to bid for those securities come at the expense of other asset classes.  Equity prices will thus suffer the loss of bidding and equity markets will drop as they always do when the Fed contracts its balance sheet.  How far?  Considering that the Fed balance sheet has been expanded by $3 trillion on its way to $4 trillion by the end of 2013, and that $3 trillion has been levered up through bank system lending, then more than $3 trillion must eventually come out of other asset classes to buy securities back from the Fed.  The total capitalization of the American stock markets is less than $20 trillion.  If all funds to buy the Treasuries sold by the Fed come from the US equity market, then the equity markets have a long way to fall; the longer the Fed continues its QE the further the stock markets will eventually fall to normalize markets.  Selling begets selling.  As the banks stop lending as they lose capital provided by the Fed, economic contraction will ensue, as it always does: the early 1980 on steroids. 

There is no easy or painless way for the Fed to reverse its policy, contrary to what Bernanke testifies. 

EPual Jacobsen

Feb. 25, 2013, 11:25 p.m.

I agree with the fact of the resultant confiscation, confiscation of those who are “savers” or “responsible”.  Accordingly I detest the manner.

However, even if I provide the benefit of the doubt to the THEORY

I think what is missed is the actual APPLICATION
and accordingly the benefit of the doubt of the THEORY is immediately nullified and we race toward oblivion.

Case and Point - Bright Line ====  Cyprus   ====  Could Keynes have imagined the bailout of the tax haven, or as many may say illegal hiding of assets ? 

You may want to take a peek at this, and if you find interesting I would enjoy your post about it.

Cyprus elections, people seem to have overlooked that.

Anastasiades faces bailout talks after victory in Cyprus elections
ekathimerini.com , Monday February 25, 2013
http://www.ekathimerini.com/4dcgi/_w_articles_wsit…

what Cyprus is claimed to be

Cyprus a channel for attracting investment to Russia
ekathimerini.com , Friday March 16, 2012

In the last five years alone, the Russian economy has seen Cypriot investments of over $52 billion, of which $41.7 billion was invested in the 2007-10 period, or 2.7 times more than German investments in Russia in the same period.

http://www.ekathimerini.com/4dcgi/_w_articles_wsit…

others say perhaps an illegal tax haven

http://www.testosteronepit.com/home/2012/11/4/the-...

Does the US and EU bail out Swiss banks holding “secret” accounts for rich US taxpayers? 
Does or will US and EU bail out Bahamas and other offshore banks holding “secret” accounts for rich US taxpayers? 

This could get interesting. Will the Germans agree to effectually bail out Russian wealthy ?
Will the rest of the EU ? Will US chime in through QE and IMF ?

 

As we bail out the illegal under the guise of a Keynesian assist
we fall deeper and deeper into the sandhole, and the sides keep
caving in despite the depth we dig.

Michael Schwartz

Feb. 25, 2013, 1:44 p.m.

Reinhart and Rogoff indeed tell us that ‘this time is not different’ - the difficult question is ‘what are we not different from?’ Are we not different from 1928 when the over-leveraged economy was due to crash, or are we not different from 1936, when too-soon austerity led to years more of depression?
You quote them saying:
...Highly leveraged economies, particularly those in which continual rollover of short-term debt is sustained only by confidence in relatively illiquid underlying assets, seldom survive forever, particularly if leverage continues to grow unchecked.
While the US economy was certainly over-leveraged in 2007, there has been a huge amount of de-leveraging since then - both in the private sector and in the non-federal government sector. The increase in debt by the Federal government has not been any where near enough to balance this deleveraging. So US leverage does not ‘continue to grow unchecked.’
And while the economy in 2007 was partly sustained by overconfidence in illiquid housing assets, it is hard to see how that is true of today’s government debt.
Reinhart and Rogoff also point out that in the aftermath of financial crises, government debt almost always increases sharply. As John Mauldin often points out, it is mathematically true that if the private sector deleverages (and the balance of payments stays about the same) then the public debt must increase. In Reinhart and Rogoff research, this public debt increase is a normal and almost necessary part of the recovery from a financial crisis, as a way to sustain private deleveraging and prevent total financial meltdown.
So if today is ‘not different’ from other examples of post-crisis recovery, the proper policy is continued government support for private deleveraging, with solid plans laid for long term government debt reduction. Short-term austerity just makes us ‘not different’ from 1936, and liable for more unneeded economic pain.

Ski Milburn

Feb. 23, 2013, 10:56 a.m.

Whoops!  I can see that commenting while fixing dinner and drinking wine can induce a certain dyslexic aspect.  Should have read:

“Keynes proposed that we dampen the wild swings of the business cycle by running deficits in bad times and surpluses in good times.”

Another minor correction upon reflection.  In Russia “everyone” had too many rubles and no inventory, in America, “everyone that counts” has too many dollars and no returns.

But my conclusion stands.  We’re all Naissur’s now.

mlgallion1@att.net

Feb. 23, 2013, 6:22 a.m.

I do not hold Lincoln in such high regard as you. We were the only country that required the killing and maiming of one million Americans to abolish slavery. And even following that long, arduous war, discrimination and slavery was not abolished by the stroke of a pen. I believe the War between the states was the the greatest usurpation of our Constution in history and led to our untamed federal governmental largess today. Many historians think that the southern states would have reunited with the union prior to the 20th century without the killing and maiming of one million Americans. And our founding fathers thought that secession was permissible, if you look at their original statements and facts surrounding ratification of our constitution. Why do so many allow cultural myth to debunk historical facts? I realize trampling on the Lincoln Legacy may put me at odds with a few, but so be it. The truth will set us all free. You could use a better example than Lincoln. His own words betray his real racist character, if you are familiar with what he actually said.

Gordon Davis Jr

Feb. 23, 2013, 3:17 a.m.

If Japan is any indication of what is possible, we should be able to expand the national debt by at least another order of magnitude or so. As for the Fed balance sheet, does anyone really know what the practical limits are? We have only a few years left of relative deficit stability.  Then, our unfunded liabilities will kick in with a vengeance. No where near enough time to allow the Fed to begin unwinding. The reality is we have already chosen our path of increasing deficits, growth of the Fed balance sheet and the long term devaluation of the dollar.

jpeseeker@gmail.com

Feb. 23, 2013, 1:30 a.m.

You wrote:Much like that crisis needed Lincoln, the current crisis needs someone who can identify new tools to resolve the present economic crisis. Until then we are condemned to a path which leads to further currency debasement and the erosion of purchasing power, with the result being a massive transfer of wealth from creditor to debtor. Without a new economic paradigm, the deleterious consequences of the current misguided policies are a foregone conclusion.

Well, how are ‘new paradigms’ invented or recognized?  It is very difficult since everyone involved is inside the current one.  You cannot ‘think outside the box’ as is so often said.  Thus, we are stuck right now because there is nothing of significance on the horizon that would qualify for “new paradigm” status because the whole world is in essentially the same ‘box’, some more so than others. 

We should be looking outside the field of economics to find our way forward.  What is emerging science or new understanding in the fields of biology, astronomy, sub-particle physics, etc. that might point the way towards a system of deeper mutuality, support and general well-being?  Better brains than mine need to ponder how we observe ourselves from Mars, having never been here before.  That is what is required. Spending isn’t going to work, austerity is not working where it is being tried; these are the poles of the continuum and the solutions won’t be found there.  How might fractal mathematics inform our economics? How might Open Space Technology inform economic policy?  How might Positive Deviance cause people to discover what works?

I don’t know the answers to those questions but I do know those inside the system are highly unlikely to change it.  “Prudens quaestio dimidium scientiae”—-to ask the proper question is half of knowing. We need to discover the proper questions.

Hang emhi

Feb. 22, 2013, 10:14 p.m.

Google “rogoff and reinhart reverse causality”.  Economies in trouble end up with high government debt, it is not the other way around.  “This Time is Different” should have been called “Lies, damn lies and statistics” especially since it has gone so mainstream largely because the know-nothing deficit hawks (most of the country) finally got the “proof” they needed since there is no other existing proof that austerity does anything other than turn recessions into depressions. 

Meanwhile, there is a new economic paradigm.  Several competing schools from Monetary Realism, to MMT, to Positive Money to the Circutists have identified that Keynes, and therefore just about every mainstream economist today don’t realize that money is created upon the issuance of a loan, and therefore private sector debt levels are what should be monitored if you want to know when economic collapse is coming.  Further, debt of a nation sovereign in its own currency will never go bankrupt and can borrow essentially forever - a government deficit is a private sector surplus, so they are creating their own demand - the more debt they issue, the more money available to buy their debt.  Before thinking we can issue debt to eternity and make everyone rich, the constraints are inflation, crowding out and incentivizing something for nothing.  We’re committing all kinds of mistakes today, but one of them is not the US gov debt level, except of course the spending that does the above 3 things.  By not understanding private sector debt, and therefore focusing on the most benign debt, gov debt, with idiotic papers from statisticians who clearly don’t know debt either, we’re only exacerbating the problems.

reese@library4science.com

Feb. 22, 2013, 8:21 p.m.

What we should have is a Keyensian variable value added tax which has the rates tied by law to GNP growth.  This would be automatically countercyclical and would not be subject to political interference without a large consensus.  The idea is illustrated in the table below but the rates are just examples.

Keyensian VVAT Plan.

Variable Value Added TAX

GDP Growth vs Tax Rates

-3 %    -8%
-2 %    -6%
-1 %    -4%
0 %    -2%
>0% <3%  0%
3 %  2 %
4 %  4 %
5 %  6 %
6 %  8 %
>7%  10 %

If scheme starts in a recession then the negative payments are paid by selling Key VVAT bonds, all tax revenue from the VVAT must be any used to pay off existing VVAT bonds.


After any existing Key VVAT bonds have been paid off all tax revenue is “paid” into Key VVAT savings up to 10% of GDP (= two years payout in an average recession) for use in the next recession.

Revenues > 10% GDP and < 30% of GDP are paid into Key Infrastructure savings accounts and may be used in the next recession on public infrastructure projects.

Revenues > 30% can be used to reduce the deficit and/or debt.

Ski Milburn

Feb. 22, 2013, 7:53 p.m.

Keynes proposed that we dampen the wild swings of the business cycle by running surpluses in bad times and deficits in good times.  My take on his idea was that budgets would be roughly balanced in the long run as a result.  Well, our politicians only learned the first half of the lesson, and so in 1981, with the inaguration of President Reagan, we entered the age of permanent deficits, and continuous stimulus.

It was a good way to jack up our economic growth rate and obliterate the Russian threat, but along the way we got addicted to deficits like a Wall Street tycoon with a cocaine “problem”.  Maybe we’ll stop tomorrow, but right this minute, all we need is a little more blow.

Well, it’s morning in America, but we’re looking at it from the wrong end of the day.  Our bag is empty, and our connection is telling us we’re bumping into our credit limit.  Happy to make a seven a.m. delivery, but he wants cash this time.

We’re all Russians now.  Everybody has more money than they know what to do with, but they can’t buy anything worthwhile with it because nobody knows what anything is worth anymore, or what the future will hold.  Meanwhile, the government is listening to every form of communication, and we’ve abandoned due process in favor of issuing Executive Orders to kill Americans.

Don’t worry about it.  Every cloud has a silver lining, and this too will pass.  Look at Russia, the successor state to the USSR, and a bunch of spinoff states with names, not initials.  Same thing coming to the USA, and sooner than you think.

We’re all Russians now.